The IMF Says Australia's Big 4 Get A Huge Government Subsidy And Need More Capital

A day after the first round of submissions were due to be given to the Murray Financial System inquiry comes a report from the IMF saying that banks which are deemed too-big-too-fail benefit from the implicit Government support that this status conveys.

In the Australian context this means Australia’s major banks, (aka the Big 4 – ANZ, Commonwealth, NAB and Westpac) which Australia’s banking regulator, APRA, has already nominated as Domestic Systemically Important Banks (D-Sibs).

While they don’t say how much the subsidy is worth, in Australia the IMF quantifies the value of the subsidy as “$70 billion in the United States, and up to $300 billion in the euro area”. If the Australian economy is about 11 times smaller than the economy of the United States, and most likely more concentrated in terms of banking, we could surmise that a subsidy at least north of $5 billion is being received by our majors.

More troubling though, and why the IMF – in contrast to David Murray’s comments yesterday about capital- continues to push for large capital buffers for the banks, is that the IMF says:

This implicit subsidy distorts competition among banks, can favor excessive risk-taking, and may ultimately entail large costs for taxpayers. While policymakers may need to rescue big banks in distress to safeguard financial stability, such rescues are costly to governments and taxpayers. Moreover, the expectation of government support reduces the incentives of creditors to monitor the behavior of big banks, thereby encouraging excessive leverage and risk-taking.

In the case of Australia’s banks, the IMF says if the chance of survival in a big risk event is to 99.9%, the Australian banks need to hold between “–0.9 to 2.8 percent of risk-weighted assets (RWA) at the end of 2011. If the goal were to achieve a 99.95 percent probability of no default, additional Tier 1 capital ranging from 1.4 to 5.2 percent of RWA would be necessary.”

But while calling for more capital is fairly straightforward, how to deal with the majors in the market is not and it’s a tough problem to deal with given that the structure of the financial system both in Australia and the globe has grown up over many decades. To this end, the IMF says that “excluding the possibility of government support for big banks may be neither credible nor always socially desirable”. Equally they say trying to restrict size is not the answer, as it is likely economically efficient.

Rather the IMF argues that “policymakers can enhance capital requirements, and possibly recoup taxpayers’ costs from those banks through a financial stability tax.”

Mr Murray and the banks may think APRA is a little heavy-handed with their new capital requirements and their interpretation of Basel III, but the IMF is firmly in their corner.